USCIB Statement on U.S. Tax Implications of the EMU

INTRODUCTION

This memorandum has been prepared in response to Announcement 98-18, to recommend that Treasury/IRS consider certain general principles and specific technical recommendations for the purpose of providing guidance to U.S. taxpayers with respect to the U.S. tax consequences of the conversion, on January 1, 1999, of eleven legacy currencies into the Euro. The general principles and specific technical recommendations are set forth below.

The USCIB advances the global interests of American business both at home and abroad. It is the U.S. affiliate of the International Chamber of Commerce, the Business and Industry Advisory Committee (BIAC) to the OECD, and the International Organisation of Employers. As such, it officially represents U.S. business positions in the primary intergovernmental bodies, and vis-…-vis foreign business and their governments.

1. General Principles:

·         The compulsory nature of the conversion by taxpayers to the Euro should be recognized.

·         Such compulsory event, which, with limited exceptions, results in no immediate economic gain or loss to taxpayers, should not accelerate the recognition of taxable gain or loss.

·         Taxpayers should be advised with clarity and in a timely manner.

·         Simplicity should be paramount with respect to any additional accounting that is required by the conversion, and rough justice (rather than overly complex record keeping and computations) is probably all that the Treasury/IRS and taxpayers need, or can afford, to reflect this unique event.

2. Specific Technical Recommendations:

·         In the context of continuity of contract, under no circumstance should the mere conversion of a legacy currency into the Euro rise to the level of the "material difference" standard of case law or the "economic significance" standard of the regulations, and, therefore, the conversion should not constitute a recognition event under - 5/8 1/8 NL 1 - 1001.

·         No formal application should be required with respect to the change in accounting method that results from the change in functional currency directly attributable to the Euro conversions; rather, it should be automatic, with no requirement for taxpayers to await specific approval, provided the taxpayer consents in its tax return and, in fact, follows the requirements set forth in the relevant pronouncement.

·         In the case of a Qualified Business Unit ("QBU") with a legacy functional currency and non-functional currency financial assets or liabilities (i.e., Section 988 transactions) denominated in another legacy currency, a carryover basis (or, alternatively, the computation of gain or loss with recognition delayed until the occurrence of a normal triggering event) should be provided.

·         In the case of a QBU with a legacy functional currency having a branch QBU with a different legacy functional currency, the - 5/8 1/8 NL 1 - 987 gain or loss, which has built up over the history of the branch, should be recognized ratably over a period equal to the branch's historic life, but in no event more than ten years beginning in 1999.

BACKGROUND

Over the next four years and two months, a number of important events in the Euro conversion are scheduled to occur, as follows:

1.       During May 1998, the E.U. will establish which European countries will participate in the first conversion and determine the bilateral forward exchange rates between those legacy currencies.

2.       On the last day of December 1998, the E.U. will determine the exchange rates between the legacy currencies and the Euro.

3.       On the first day of January 1999, the Euro will come into being and the status of the legacy currencies will be reduced to that of representations of the Euro, with two important governing principles to apply:

·         The continuity of contracts principle (i.e., that the conversion to the Euro has no effect upon existing contractual obligations), which has been codified in E.U. legislation as well as in certain of the states in the United States.

·         The following three year period (January 1, 1999-December 31, 2001) will be one of "no prohibition and no compulsion" with reference to doing business in Europe's.

4.       No later than the first day of January, 2002, but no sooner than the first day of July, 2001, Euro paper currency and coins will be issued.

5.       On the first day of July, 2002, the legacy paper currency and coins will cease to be legal tender, even as representations of the Euro.

DISCUSSION OF TAXPAYER CONCERNS

- 5/8 1/8 NL 1 - 1001 Issue

The conversion to the Euro alters one of the terms of numerous financial contracts which were previously denominated in legacy currencies. While some, more recently entered into, contracts may address this conversion, most do not. They are, however, clearly governed by the continuity of contract principle which is part of the E.U. legislation. A number of US jurisdictions have also passed similar legislation to assure that the conversion has no effect on existing contractual obligations. Of course, in order to handle some relatively insignificant but nonetheless existent "housekeeping" matters that have not always been consistently applied throughout Europe (e.g., the length of a contract year (360 vs 365 days), the number of days in a month (30 vs actual) for purpose of computing part year interest, etc. ) or that are the direct result of the conversion (e.g., rounding in the calculation of the conversion of different legacy currencies into the Euro), some additional conforming legislation, which would impose, in some cases, minor contractual changes, will be needed. Although it is reasonable to conclude that none of the changes rise to the level of the Cottage Savings "material difference" standard or the regulatory "economic significance" standard, we believe that Treasury/IRS has the authority to provide, and taxpayers need the certainty of, assurance that the Euro conversion is not a triggering event under Section 1001.

The Subpart J issues

The primary concern is whether or not the Euro conversion results in a change in functional currency in the case of a QBU having a legacy currency as its functional currency. While there are technical arguments for treating the conversion event as either a change in functional currency or a "redenomination" (i.e., not a change in functional currency), in fact, there is perhaps more concern over the disadvantageous economic and administrative consequences that will result from a change of functional currency treatment (probably, the technically correct answer). We believe that Treasury/IRS has a very broad authority, under Subpart J, to provide definitive guidance to taxpayers that a change of functional currency resulting from the Euro conversion will be treated in an even handed and administratively efficient fashion. In this connection, we suggest the following:

1.       No formal application should be required to obtain permission to effect the change in accounting method resulting from the change in functional currency attributable to the Euro conversion. In lieu thereof, such permission will be automatic, not requiring taxpayers to await specific approval, provided that a taxpayer consents in its tax return and, in fact, does follow the requirements set out in the relevant notice.

2.       Provide assurance that the immediate tax consequences provided in regulations in the following two cases will not apply with respect to the Euro conversion:

I.                     In the case of a QBU with a legacy functional currency and non-functional currency financial assets or liabilities denominated in another legacy currency (i.e., - 5/8 1/8 NL 1 - 988 transactions), rather than immediate recognition of gain, a carryover basis should be the rule, (or, alternatively, the computation of gain or loss could be made but recognition thereof delayed until the occurrence of a normal triggering event). Incidentally, with regard to this item (as well as the next item below), there is some concern that those on a 52-53 week year might somehow be treated unfavorably because their current taxable year technically ends in early January 1999 rather than on December 31, 1998. We believe that Treasury/IRS certainly has authority to, and should, assure that this will not be the interpretation.

II.                   In the case of a QBU with a legacy functional currency which has a branch QBU with a different legacy functional currency, Section 987 gain or loss, which has built up over the history of the branch, should be recognized ratably over a period equal to the branch's historic life, but , in no event, more than ten years, beginning in 1999. Although it is clearly possible to create, as others have suggested, a new accounting system to properly track the "pre '99 equity pool", so as to identify the theoretically correct time to recognize this gain or loss, we believe such an approach will be more administratively burdensome for taxpayers to develop and maintain, and for the IRS to audit, than is commensurate with the benefit to be achieved. Our rough justice alternative of recognition over the historic life of the branch, but no longer than ten years, is easily administrable and auditable and, over time, disadvantages neither the IRS nor taxpayers.

Conformity issue

Although, for several reasons, it would be advantageous to assure, to the extent possible, conformity between the manner in which the US and the various E.U. countries treat the conversion to the Euro, that is probably not possible. Although the E.U. did encourage tax neutrality, the Union itself has no authority over national income taxes and, apart from the Euro conversion, there have always been a variety of treatments in the member countries of foreign exchange gains/losses (e.g., some countries recognize unrealized gains and losses , others follow book accounting which tends to anticipate losses but not gains (conservatism)). These inconsistencies will create additional tension to taxpayers, but, in addition, the inconsistencies between the US rules and the host country European rules has the potential of creating a mismatch between the incurrence of European country income taxes and the recognition, for US purposes, of the taxable income giving rise to the various European taxes. Such mismatch could unfairly limit the US foreign tax credit relief for US multinational corporations.